This article is what I am calling a Primer. It is intended to quickly introduce you to a topic and provide enough information that you can explore it further (possibly through later articles on Analog Revolution). This Primer is an informative look at cryptocurrencies, like Bitcoin.
What is Bitcoin?
Bitcoin is a name you may well have heard in passing or as a metonym for cryptocurrency as a whole. Bitcoin is but the first and most well known cryptocurrency.
Cryptocurrencies are digital mediums of exchange. Each cryptocurrency (or “crypto”) is slightly different and may make use of different encryption techniques. Each crypto protocol (system) is called a “specification.”
There are a variety of cryptocurrencies, and Bitcoin just gets the most press coverage. My personal favorite is Dogecoin, a currency that gets its name from the Doge internet meme. You can see a multitude of currencies, and their current values at coinmarketcap.com.
The greatest point of division between cryptocurrencies is Proof of Work versus Proof of Stake. Simply put, Proof of Work currencies require input by the user’s computer to garner new coins a.k.a. “mining” while Proof of Stake currencies require a user to hold coins to increase their share of newly released coins. Mining cryptocurrencies employ difficult mathematical problems that are solved in exchange for a new coin. Each new coin is harder to get than the last (just like gold, the number of possible coins is finite). Proof of Stake currencies incentivize holding more and more coins and can guarantee a particular return on investment (in terms of more coins).
Alright, but why do people care?
Cryptocurrencies are not managed like government-backed fiat currencies. People who don’t appreciate or believe in the currency or leadership of their government can store and transfer wealth by different means.
Cryptos are decentralized, so that no single body exercises complete control over the currency. The persons or organizations that create each protocol exercise control during the creation but not the duration. Meaning that somebody has to choose whether it will be a Proof of Stake or a Proof of Work currency, and how those systems are implemented, but once the protocol is launched there is no real oversight.
Cryptos rely on their network of users to validate exchanges and regulate the production of new units of currency. The specific methods of exchange validation and currency production are computer processes beyond the scope of this article and, quite frankly, my research. The production of new currency is a bit more tangible. Allow me to illustrate it, with some extra fluff, thusly:
So, imagine we at Analog Revolution create a new cryptocurrency and each unit is an Analog Revolver. The coins could be our logo with a hex code along the ribbon (wouldn’t they be cute little…whatever, anyways). When we create the currency we decide that this will be a Proof of Work system because we don’t want people to get rich off of us without putting in any effort. We also stand to gain exposure and wider use (some variation of market share) because the user is not offered extra incentives to hold onto their Revolvers.
We craft the system to mirror Bitcoin, but we think it is better because we did it ourselves. Bitcoin uses “blocks” to validate its transactions. Blocks contain a list of all transactions of Bitcoin that have occurred since the previous block, as well as a problem to be decoded in exchange for a new Bitcoin. Persons mining Bitcoin are also validating all of the Bitcoin transactions. Bitcoin is designed to release a new “block” every 10 minutes or so, according to its wiki. We’re going to be way more popular than Bitcoin and want our transactions to occur more quickly so we design ours to release a new one every 5 minutes.
Okay, so when we launch there are two possiblities (hyperbole for the sake of simplicity):
One, we launch to great success and get millions of users almost immediately. These users are mining Revolvers, and, as a result we have a huge network of people validating each other’s transactions while mining for new Revolvers. This is great, and we now have a successful network with millions of people all trying to get the next
Two, we launch and nobody cares. We now have a protocol that exists on, like, two computers and a network consisting of no computers because even we won’t waste the electricity mining our useless currency. Now we have no network validating our exchanges, but that isn’t a big issue considering we have no exchanges. The point here is that we don’t have any new currency being produced because no one is producing it.
Cryptocurrencies and government-backed currencies are managed differently, but they are just different breeds of the same beast. That beast is the fiat currency.
Fiat currency refers to any medium of exchange that lacks intrinsic value. Food, water, and shelter have intrinsic value to human beings; they can all help keep us from becoming dead (if only for so long). That is not to say that they have definite value, since all value attributed to these things is qualitatively determined by the human observing them, just as it is with currency.
As a medium of exchange, all value is derived from the belief of value. The US Dollar has no intrinsic value; it has no use outside of its own economical construct. The US Dollar is only worth something because people believe it is worth something. If the governments of the world fall, the British Pound, Japanese Yen, US Dollar, and Euro will become meaningless slips of ink and paper; similarly, Bitcoins are only strings of numbers or pieces of data. (I acknowledge that the word perceive may be a more apt substitute for believe, but the semantics of the matter are less relevant.)
Cryptocurrencies and government-backed currencies are intrinsically valueless, but cryptocurrencies have something else to offer: Scarcity.
All paper currencies suffer from inflation and deflation (change in value per unit currency over time). There is not one single cause for this economic phenomenon, but there is one that cryptos can totally avoid: Increase in money supply. The United States Fed can choose to print more money than it shreds each year. Doing this can help to regulate the rate of inflation and the Fed chooses to do this in order to keep inflation at around 2%, which is considered healthy for a growing economy (Side note: Old posters advertising Coca-Cola for a nickel and brand new 1969 Mustangs for $2500 do not indicate that products have become many times more expensive. Instead, money has become less valuable, in part because there is more of it.)
Zimbabwe is the obvious example. For a number of years Zimbabwe suffered from Hyper-Inflation. Money lost value in the time it took to overpay in cash and receive change. The leader of Zimbabwe simply printed more money to pay off debts, and, in doing so, ruined his country’s economy. Preventing this scenario is the argument for a gold or silver standard: It limits the amount of money in circulation, and any dollars printed are representations of precious metal held by the printer.
At the second that you are reading this, there is a finite amount of gold in the universe. There is a finite amount of gold on Earth. Cryptocurrencies are (with few exceptions) also finite resources. There will be a “last Bitcoin,” but the US government can create an infinite amount of new money. Printing infinitely is not possible, of course, but the promise of money (savings accounts and digital banking) can become infinite.
And there you have it. Cryptocurrencies are digital mediums of exchange set into motion by individuals and maintained by a network of users. They differ from other more standard fiat currencies because they are decentralized and scarce. Some people thing that cryptocurrencies are the future, others think that they are a passing fad. All that remains is to stick around and find out.